Wednesday, July 12, 2017

The fragility of our financial buffers will only be revealed when they fail in the next crisis.

While buffer has a specific meaning in chemistry, I am using the word in the broad sense of a reserve resource that absorbs the initial destructive impacts of crises or system overloads. Marshland along a sea coast is a buffer against destructive storm waves, for example.

A savings account acts as a buffer against financial drawdowns or losses of income that would otherwise quickly cascade into a full-blown crisis.

Redundancy of resources can act as a buffer. If an airline maintains an aircraft in reserve, this reserve plane acts as a buffer against the disruption to the airline's scheduled flights should one of its aircraft be unexpectedly removed from service by a mechanical failure. The reserve aircraft can replace the plane that was withdrawn from service with minimal disruption.

Stockpiles act as buffers against supply disruptions. A storage tank of oil buffers a refinery against any delay in its incoming shipments of crude oil. Supplies of food and water buffer against severe natural disasters that disrupt regional water service and food deliveries.

Credit can act as a financial buffer against unexpectedly high expenses or declines in revenue. If a tire on our vehicle goes flat during a road trip and we only have a few dollars cash, a credit card buffers the disruption by funding the replacement tire and labor.

But over-using credit can end up thinning our financial buffers. If someone starts using their credit card not as an emergency buffer but to augment their cash income--in effect, acting as if the borrowed money was a pay raise rather than a loan--their credit line diminishes to near-zero and when they actually need credit for an emergency, it's no longer available.

A key feature of buffers is that it's difficult for observers to tell if they've been thinned to the point where they can no longer stave off disruption. Outside observers can't tell if the oil storage tank is full or empty, or if an individual's credit card is maxed out or has a completely untapped credit line.

In terms of our economy, there are indications that our financial buffers are thinning to the point of failure. Millions of households have less than $500 savings--an essential, basic buffer against unexpected expenses.

Millions of households have borrowed money to make up for stagnating or declining income. Charting master Lance Roberts of Real Investment Advice published this chart showing how debt has been used to maintain households' standards of living:

Central bank balance sheets acted as buffers during the 2008-09 global financial crisis. But instead of rebuilding this buffer by letting balance sheets slowly decline (i.e. as bonds owned by the central bank reach maturity), central banks have thinned the buffer by rapidly expanding balance sheets during the current slow-growth expansion:

The ability of governments to borrow and spend during recessions is a key macro-economic buffer. But instead of slowing fiscal borrowing and spending, the U.S. government has ramped up borrowing immensely, thinning the buffer available for future fiscal stimulus:

If we survey the financial landscape for fully intact buffers, we find none. Every buffer has been thinned by the past eight years of extreme monetary and fiscal policies and financial leverage, that is, debt piles ever higher on an unchanged foundation of collateral.

All the buffers that absorbed the shock waves of the 2008-09 Global Financial meltdown have been drained or thinned to the point that they no longer have the capacity to absorb the next global financial crisis. From the outside, the "tank" may appear full, but it's almost empty.

The fragility of our financial buffers will only be revealed when they fail in the next crisis.

Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.

Our Privacy Policy:

Correspondents' email is strictly confidential. This site does not collect digital data from visitors or distribute cookies. Advertisements served by third-party advertising networks such as Adsense and Investing Channel may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative)If you have other privacy concerns relating to advertisements, please contact advertisers directly. Websites and blog links on the site's blog roll are posted at my discretion.

Our Commission Policy:

Though I earn a small commission on Amazon.com books and gift certificates purchased via links on my site, I receive no fees or compensation for any other non-advertising links or content posted on my site.

Weekly Musings Reports

"What makes you a channel worth paying for? It's actually pretty simple - you possess a clarity of thought that most of us can only dream of, and a perspective that allows you to focus on the truth with laser-like precision." Jim S.

The "unsubscribe" link is for when you find the usual drivel here insufferable.

Contribute via PayPal

Why I gratefully accept donations and why you might want to donate:

A 95-minute movie with 10 minutes of ads and a small popcorn costs $25.
If you enjoyed this site for at least 2 hours this year, and you donate $25, you already received more entertainment than you did from the movie. The other 100+ hours of enjoyment you receive here is FREE.

Subscribers and donors of $50 or more this year will receive exclusive weekly Musings Reports.

You have the immense moral satisfaction of aiding a poor dumb writer who seeks to inform, entertain and amuse you.

Contribute via Dwolla

Dwolla members can now subscribe to the weekly Musings Reports with a one-time
$50 payment; please email me,
as Dwolla does not provide me with your email: